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What is A Network Effect?

BitForex Editor
Jan 11, 2021

When pricing your products, platform, or services, it is necessary to take into account various factors to ensure you are going about it the right way. It is essential to understand the unique value your product offers, the willingness of your customers to pay for that value as well as the profit margins which are necessary for your company to reach its goals.

It is also essential to note whether your service or product is subject to any network effects which could, in the long run, affect your pricing strategy. The concept of network effect can seem difficult to understand at first, but in a real sense, it is quite simple. With a proper understanding of network effects, platform designers can easily put in place platform growth techniques based on their knowledge or understanding of network effects. However, if you are not familiar with network effects, there is no cause for alarm as this article will not only give a detailed overview of what network effects are but also how they can impact business strategy as well as how they can be used to increase your profitability.

Definition Of A Network Effect

The network effect basically refers to a phenomenon whereby an increased number of participants or people improve or boost the value of a service or goods. An excellent example of the network effect is the internet; originally, there were few users on the internet as it was of little value or benefit to anyone apart from those in the military as well as research scientists.

Eventually, as an increased number of users were able to access the internet, they produced more information, content, and services. The improvement, as well as the development of websites, drew more users to connect and also do business with one another. However, as the internet was faced with an increase in traffic, it provided more value, which in turn led to a network effect.

To better explain, the phone can only be useful to people if there are other people who also have a phone of their own. If only a single individual owns a phone, there is no doubt that the value of the phone's network will be equal to zero as they cannot do anything with the network. However, if another person also owns a phone, the first person can easily use their phone to place a call to the second person, and if that provides some benefit to them both, then the network has some value. In other words, if everyone has a phone, then the phone network serves as a significant value to all users.

The Network Effect Explained

It has been implied that the network effect can result in a more improved experience as more individuals participate, plus it also encourages new users as they aim to benefit from the network. One place that network effect can be found is throughput social media. To cite an example, as more people continue to post information or content on Twitter like media and link, the more the platform becomes more useful to the public.

The network effect is responsible for an increased growth rate among networking platforms like Instagram, YouTube, and Facebook. Numerous network effects have also taken place as a result of more people joining social media platforms. As there are more individuals who join and participate, companies who are seeking to create awareness about their products and services can easily join these sites in other to capitalize on the trend. A rise in advertisers results in more revenue for social media websites, which in turn allows the sites to evolve and provide more services to the consumer.

Types Of Network Effects

Though the concept of phone network with a proper understanding of the subject can be easy to understand, it is, however, necessary to know that there are different kinds of network effects, which include;

1)Direct network effect

The direct network effect also referred to as the same-side effect usually arises when a user or individual benefits directly from the addition of new users. In this case, the value of a service increases as the number of users also increases; for example, existing users on the internet will gain from the addition of new online users. Phones also fall into this category as the more people have phones, the more it becomes useful to own one yourself.

2)Indirect network effect

The indirect network effect is also referred to as a cross-side network, and it usually occurs when there is an increase in the users of the original product, not as a result of any direct gain but because of the effect of some complimentary product that brought about the use of additional products. For example, existing users on the internet will undoubtedly gain from the addition of new users that are created by expensive laptops available on the market.

Another example is taking Uber; as more riders become part of the platform, the more valuable and useful it becomes to the drivers as they have more business opportunities. There is also the reverse as riders have more locations available and shorter wait times as more drivers join the network, thus making the network more valuable.

3)Bilateral network effect

The bilateral network occurs as a result of an increase in users of a complementary product as well as the users of that product benefit. For example, the amount of internet users rises as a result of a rise in people who use smartphones. The relation of both products increases the number of users of the internet.

4)Local network effect

The local network effect arises when a user's gain is affected by a small group of members instead of the whole set of members. To cite an example, someone who uses instant messenger will gain if their friends signed up for a similar instant messenger app; however, he/she will not benefit anything from a general increase in users.

Today, it is safe to say that the network effect has played an essential role in the evolving and general improvement of ride-sharing services such as Lyft and Uber. Not just ride-sharing services, as numerous fast-growing and leading companies like Apple's app store and Facebook, have also attained success because of network effects. If adequately leveraged, they are capable of increasing the profitability and growth of any business.

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